Deutsche Bank's new shareholder hedged its stake

JennyStrasburg

Deutsche Bank AG's new biggest shareholder, Chinese conglomerate HNA Group, used more than EUR2.6 billion ($2.8 billion) in financing to help buy its nearly 10% stake in the German lender and protect itself against potential losses on the position.

Bankers and analysts familiar with such transactions said the disclosures suggest a heavier reliance on financing than they would consider typical for most large investors building a similar holding. Some of them said that investment banks have been competing fiercely for HNA's business as it goes on a global buying spree.

In February, Deutsche Bank disclosed for the first time that HNA had a major stake, of about 3%. HNA then began a series of transactions that more than tripled its stake, to 9.92%. The purchases catapulted HNA to the top of the lender's shareholder roster. Bankers and investors have cited the HNA purchases as a show of strength in the bank.

Yet the filing, made May 2 with the Securities and Exchange Commission, show HNA didn't just shell out cash to buy the new shares. It tapped more than EUR2.6 billion in financing, mostly from UBS Group AG. With that money, it bought shares and established derivatives positions that would compensate it if Deutsche Bank's share price fell while sacrificing some gains if it rose.

The derivatives structure, known as a collar, limits HNA's risk -- and its potential reward.

HNA's 204.7 million shares were worth roughly EUR3.6 billion at Wednesday's EUR17.49 share price. Deutsche Bank shares are up a little more than 1% this year and have almost doubled from the multiyear lows they reached in the fall. Most of HNA's new shares were bought in late April for EUR16.70, including fees, according to the filing.

Its stake is held through Austrian asset manager C-Quadrat Investment AG, which manages HNA's Deutsche Bank investment, according to people familiar with the matter and the U.S. regulatory filing.

Including brokerage and financing fees, the filing said HNA's share purchases cost EUR3.4 billion. Roughly 32 million of the shares came at EUR11.65, the discounted price at which Deutsche Bank sold rights in its recent $8.5 billion capital increase.

Spokesmen for HNA and C-Quadrat declined to comment. A Deutsche Bank spokeswoman also declined to comment on the HNA transactions.

The limited disclosures don't reveal how much cash HNA put up to become Deutsche Bank's biggest shareholder. Bankers and others said HNA's cash outlay could have been less than EUR1 billion based on the disclosures, but they emphasized that is an estimate.

The investor, according to the regulatory filing, built up its Deutsche Bank stake based on a belief that the shares "are substantially undervalued and are an attractive investment."

UBS provided most of the financing, including one chunk of EUR2.1 billion plus part of a EUR473 million loan with ICBC Standard Bank PLC, according to the filing. The banks declined to comment.

An undisclosed portion of the EUR2.1 billion from UBS was used to finance two collars, the filing said. The trades use options to limit the investor's risk of losses if shares fall below a certain level -- in this case EUR15 and EUR16.70 -- when the options contracts expire in 2018 and 2019.

In exchange for that protection, HNA agreed in the two transactions to give up profits if the share price exceeds EUR20 and EUR21.

Collars involve offsetting cash flows -- HNA pays UBS for protection in case of low prices, and UBS pays HNA for the right to profit on high prices -- and thus aren't comparatively expensive. That suggests the bulk of the EUR2.1 billion UBS loan likely went to actually purchasing shares, say people familiar with such transactions.

Collar transactions aren't uncommon as hedges against risks in big shareholdings. But other investors could see the narrow range of the collar on HNA's Deutsche Bank investment as indicating relatively low expectations for the shares and also low risk tolerance, some financiers said.

C-Quadrat's founder, Alexander Schütz, has been nominated to join Deutsche Bank's supervisory board next week, when it holds its annual shareholders meeting.

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